The Fed Blog

Thursday, May 28, 2015

On Tuesday, the Bureau of Census reported that new home sales (a more timely barometer of the housing market than existing home sales) rose 6.8% to 517,000 units (saar) in April, but that followed a 10.0% drop in March. Nevertheless, these sales remain on an uptrend that started in mid-2011. The bad news is that the latest pace of activity isn’t much better than the previous cyclical lows in this series starting back in 1970.

The recent rebound in household formation should be bullish for new home sales. Over the past year through March, the number has increased 1.5 million, back to the fast pace last seen in the middle of the previous decade. The problem is that the number of households renting rose 1.9 million, while the number of home-owning households fell 0.4 million.

Wednesday, May 27, 2015

The major central banks of the world have been easing their monetary policies significantly since the financial crisis of 2008. They’ve succeeded in averting another financial crisis so far. They’ve also succeeded in recovering most of the fortunes that were lost during the crisis. For example, the total market value of all stocks traded in the US rose $22.7 trillion since Q1-2009 through the end of last year to $36.5 trillion. The S&P 500’s capitalization has increased $12.9 trillion during the bull market so far through last week. Both are at record highs, with the S&P 500 exceeding its 2007 peak by $5.0 trillion. All equity investors have benefited from the stock market rally.

Bond investors also enjoyed big gains as yields fell and prices rose. For example, US bond mutual funds had capital gains totaling $522 billion since the start of 2009. As we noted yesterday, the 12-month average of the median existing home price is up 29% since February 2012, while real estate held by households has increased by $4.2 trillion since then through the end of last year. Gold has also been golden, with a 118% rise in the price since the start of 2009 to its record high on September 6, 2011. It’s down 36% since then, but that’s hardly a sunken treasure for anyone who bought gold a few years ago.

Nevertheless, the central banks have been frustrated by the slow pace of the recoveries in their economies since the crisis of 2008. Reviving self-sustaining economic growth hasn’t been as easy as easing has been. Previously, I’ve argued that the ultra-easy monetary policies of the central banks might perversely have contributed to the slow pace of economic growth.

Tuesday, May 26, 2015

In my opinion, the Fed has significantly contributed to the weakness of the current economic expansion as follows:

(1) By keeping interest rates near zero for so long, risk-averse savers have had to accept bupkis for returns on their liquid assets, which rose to a record $10.7 trillion during the week of May 11. Many of them have been saving more, thus spending less. The 12-month sum of personal saving has been running around $700 billion since the end of the financial crisis in 2008, double the pace during the 1990s and the first half of the previous decade.

(2) Ultra-easy money attracted investors rather than nesters into the housing market following the 2008 crisis. They bought up all the cheap homes and drove home prices back up to levels that may be unaffordable for many first-time homebuyers.

(3) As I’ve discussed many times over the past year, thanks to the Fed, corporate bond yields have been trading below the S&P 500’s forward earnings yield since 2004, providing companies with an incentive to buy back their shares and engage in M&A rather than invest in plant and equipment.

Cheap money did stimulate some business investment, but the increased capacity wasn’t matched by more demand, resulting in some deflationary pressures. Stock prices have soared, but this has exacerbated the perception of widespread income and wealth inequality.

Today's Morning Briefing: Tiptoe Through the Soft Patch. (1) Tiny Tim and Janet Yellen. (2) Is the Great Recession over yet? (3) ECI wages get a footnote. (4) Yellen still worrying about underwater homes. (5) Three abating headwinds. (6) Fed sees 2.5% real GDP growth ahead. (7) Yellen is in one-and-done camp. (8) What’s the matter with Kansas? (9) Are the headwinds abating? (10) Here is how the Fed’s policies have depressed consumer and business spending, and housing activity. (11) What’s the matter with the dollar, bonds, and stocks? (More for subscribers.)

Thursday, May 21, 2015

The ECB isn’t buying stocks (just yet), but the bank’s officials are certainly doing their best to boost stock prices by depressing the euro and keeping a lid on interest rates. Last Thursday, ECB President Mario Draghi countered any notion that the bank’s QE might be tapered ahead of schedule. He was clearly concerned about the recent backup in bond yields, strength in the euro, and weakness in stock prices. To make sure everyone got the message, another member of the ECB’s executive board said on Monday evening that the bank will front-load some of its purchases of sovereign debt in May and June.

The forward earnings of the EMU MSCI seems finally to be turning up as both 2015 and 2016 earnings estimates have stopped falling recently. NERI turned positive during April (1.3) and rose to a five-year high in May (4.0) following 48 consecutive months of negative readings. The upturn is widespread including Germany, France, and Spain, though not Italy so far.

The weaker euro finally might be starting to boost profits in the Eurozone. There is probably more upside for the region over the rest of the year barring a Grexit.

Today's Morning Briefing: Central Planners. (1) Does kicking the can beat the alternative? (2) Why can’t a series of short-term fixes be a long-term fix? (3) The Greek example. (4) Central bankers have turned into central planners. (5) The latest plan is to do more of the same to drive up stock prices. (6) China’s new plan is to pump up stock prices. (7) BOJ buying ETFs. (8) Profits finally showing signs of life in Eurozone. (9) US lags while FOMC plays Hamlet. (10) What do Fed economists do all day? (11) Fed staff attacks Piketty and other Progressives. Read all about it! (12) Fed debates seasonal distortions. (More for subscribers.)

Wednesday, May 20, 2015

Valuation like beauty is in the eye of the beholder. With bond yields at historical lows, why shouldn’t valuation multiples be at historical highs? At 2%, the 10-year Treasury bond yield has an effective forward P/E of 50, implying that stocks trading at a forward earnings yield of 5.9% and a multiple of 17 are grossly undervalued by as much as 62%. Of course, this “Fed Model,” as I first named it back in July 1997, has been showing that stocks are undervalued since the Tech bubble burst. Furthermore, historically low interest rates may be a sign of secular stagnation, which isn’t particularly bullish.

Previously I’ve argued that valuations are being driven by equity purchasers who don’t pay much attention to valuations. They are corporate managers buying back their shares because the forward earnings yields on their shares exceed their borrowing cost of capital in the bond market. As far as they are concerned, beauty is measured by the appreciation of their stock price as they buy back their shares. In this scenario, the source of irrational exuberance is the ultra-cheap money available in the bond market for share buy backs and M&A thanks to the ultra-easy monetary policies of the Fed.

Tuesday, May 19, 2015

If oil prices have bottomed and the dollar has peaked, then forward earnings should be moving forward again. Until recently, the S&P 500 forward earnings was tracking 7% annualized growth, the historical trend for this series.

If so, then forward earnings is currently predicting that the four-quarter trailing average of S&P 500 earnings, which was $119.20 per share during Q1, will rise to around $125 early next year. I am forecasting $130 for all of 2016, up from $120 this year.

Of course, this optimistic outlook requires that the economy finds some traction to get out of its current soft patch with both business sales and industrial production rebounding from their recent dips and moving to new highs again.

Monday, May 18, 2015

While valuation multiples are flying into the wild blue yonder, revenues and earnings have been coming back down to Earth. But that’s all because of the crash in the Energy sector. Excluding this sector, the skies are still relatively sunny. Nevertheless, investors have to beware of repeating the fate of Greek mythology’s Icarus, who flew too close to the sun, melting the wax on his homemade wings and sending him into the sea. It was the first meltdown recorded in human history. Let’s have a closer look at the data:

(1) Revenues. The y/y growth in S&P 500 revenues, as compiled by Thomson Reuters I/B/E/S, is highly correlated with the comparable growth in manufacturing and trade sales. The former was down 1.8% y/y through Q1, while the latter declined 2.4% through March. However, excluding petroleum products, business sales rose 2.4% y/y. Petroleum-related sales plunged 31.7% y/y through March.

Thursday, May 14, 2015

Yesterday’s much weaker than expected US retail sales report initially caused the 10-year US Treasury bond yield to fall in the morning. Then it spent the rest of the day moving higher. The comparable pesky German bond yield continued to move higher to 0.73% from its record low of 0.03% on April 17. The US bond yield has been joined at the hip with the German one all year.

While April’s payroll employment report put a Fed rate hike back on the table yet again for June, the retail sales report arguably took it off the table--yet again. That should have been bullish for bonds. Instead, the dollar took a dive on the soft-patch sales report. The weaker dollar lifted the prices of precious metals and oil (before crude oil inventory data depressed them), which also unnerved bonds.

A 2% bond yield looks attractive for the US 10-year Treasury given the subdued outlook for the Fed’s rate hiking. The problem is that if the German yield gets there, the US yield will be closer to 3%. That would make it even more attractive as long as you didn’t buy the bond at 2%.

Today's Morning Briefing: Consumers Not Registering. (1) Less “ka-ching” around the world. (2) A demographic theory of secular stagnation. (3) Older workers can’t depend on broke social welfare states. (4) May you live a long life and have lots of savings. (5) How governments depressed fertility. (6) US retail sales join the soft-patch batch. (7) China’s senior moment? (8) Japan, Italy, and Germany are at the top of median-age ranking. (9) Spotting some shoppers in Europe. (10) Bonds learning to speak Deutsche. (11) Focus on market-weight-rated S&P 500 Retail industry. (More for subscribers.)

Wednesday, May 13, 2015

Only a few weeks ago, we all figured out why bond yields had dropped close to zero in the Eurozone. It was mostly because the ECB implemented QE on March 9, and pledged to buy bonds yielding at least the same as the central bank’s deposit rate, which was lowered to minus 0.20% on September 4.

That hasn’t changed. So why the backup in bond yields? Maybe the markets have concluded that the ECB’s QE will avert deflation and boost the Eurozone’s economic growth. The rebound in oil prices certainly helped to allay some of the deflation concerns in the bond market.

Oil prices stopped falling on January 13. The price of copper stopped falling on January 29, and is up 18% since then. Both have been highly correlated with the US bond yield over the past year. The rebound in the price of oil may be a correction of a severely oversold condition. The supply/demand balance remains bearish, but turmoil in the Middle East is recurring and tends to add a risk premium to the price of oil.

The price of copper may reflect an improving global economy in general and a strengthening Chinese economy in particular. More likely, it reflects expectations that the Chinese government will provide lots of stimulus to revive China’s growth rate, which isn’t likely to happen.

Today's Morning Briefing: Major Tom & the Fed. (1) Ground Control has lost control of the bond market. (2) Bond yields should maintain current altitude for a while. (3) Stocks ready to go into outer space? (4) A simple theory for the backup in yields. (5) Close correlation between bond yield and oil and copper prices over past year. (6) US bond market no longer for isolationists. (7) Four Fed heads speak. (8) No big surprise in Q1 earnings season’s positive surprise. (9) Financials and Health Care sectors save the quarter. (10) Energy earnings crash and burn, but S&P 500 earnings up impressive 11.5% y/y ex-Energy. (More for subscribers.)

Tuesday, May 12, 2015

Many years ago, before China emerged, the price of copper was driven mostly by demand from the US housing industry. Could it be that US housing starts are taking off, which is why copper is firming? Let’s review some of the related indicators:

(1) Employment. Residential construction payrolls rose 23,600 during April. That was the best monthly increase since the start of the current housing expansion. However, that followed a decline of 1,800 during March, the first decrease since May 2012. Then again, total residential construction employment rose to 2.45 million, the highest since January 2009.

(2) Railcar loadings. On the other hand, railcar loadings of lumber and wood products are consistent with the current subdued pace of housing starts.

(3) Lumber prices. While both are volatile, there is a decent correlation between the nearby futures price of lumber and the S&P 500 Homebuilding stock price index. I have found that an average of the two is highly correlated with housing starts. The average is down 14.4% ytd.

Monday, May 11, 2015

Fed Chair Janet Yellen has stressed the importance of wage inflation in influencing the FOMC’s decision to start raising interest rates. April’s average hourly earnings (AHE) for all workers rose just 0.1% m/m and 2.2% y/y. She has said that she would like to see 3%-4% wage gains, or be reasonably confident that they are heading in that direction. The three-month change in this measure of wages settled down to 1.8% (saar) during April from 3.6% during March. Nothing to get Yellen too excited, which seemed to get the stock market very excited on Friday.

However, Q1’s Employment Cost Index (ECI) for wages and salaries in the private sector--a more comprehensive measure of wages than the AHE rose 2.7% y/y, the highest since Q3-2008. The Phillips Curve, which posits an inverse relationship between wage inflation and the unemployment rate, is actually working much better with the ECI than the AHE measure of wages, especially compared to the short-term unemployment rate. (See Phillips Curve.)

Yellen is a big believer in the Phillips Curve. She said so in an important 3/27 speech: “A substantial body of theory, informed by considerable historical evidence, suggests that inflation will eventually begin to rise as resource utilization continues to tighten. It is largely for this reason that a significant pickup in incoming readings on core inflation will not [her emphasis] be a precondition for me to judge that an initial increase in the federal funds rate would be warranted. With respect to wages, I anticipate that real wage gains for American workers are likely to pick up to a rate more in line with trend labor productivity growth as employment settles in at its maximum sustainable level. We could see nominal wage growth eventually running notably higher than the current roughly 2 percent pace.” In a footnote, she cited four studies for “recent evidence on the relationship between labor market slack and wages.”

Thursday, May 7, 2015

US bond yields have jumped recently. The 10-year Treasury is up from a recent low of 1.87% on April 17 to 2.26% yesterday. Everyone is blaming that development on the spike in Eurozone bond yields, particularly the surge in the 10-year German government yield from its all-time low of 0.033% on April 17 to 0.58% yesterday. That’s despite the implementation of QE by the ECB starting on March 9.

With the benefit of hindsight, the backup in yields isn’t a surprise. Yields simply fell too low at the start of the year on fears that plunging oil prices might trigger widespread deflation, especially in the Eurozone, and maybe cause another financial crisis if oil companies started to default on their debts. Now that oil prices have rebounded, those concerns are evaporating and yields are normalizing. I think it’s that simple.

In any event, the backup in bond yields is doing the same to mortgage rates in the US. That could stall the already lackluster recovery in the housing industry, which might explain why lumber prices are falling. So maybe the Fed should postpone its lift-off given the lift-off in bond yields?

Wednesday, May 6, 2015

Yesterday, the Census Bureau released March data for US merchandise trade. Imports rose significantly. However, the 10.3% m/m jump in the inflation-adjusted series reflected some catching up after the West Coast port strikes ended during February.

More significantly, real merchandise exports edged up just 1.1% m/m and are showing a flattening tendency over the past year. On a y/y basis, imports are up 10.1%, while exports are up only 0.3%. The slowdown in exports probably reflects secular stagnation in the global economy as well as the negative impacts of the strong dollar and the port strikes.

Today's Morning Briefing: The World Is Flat. (1) Thomas Friedman’s book. (2) The end of the Cold War was the end of the greatest trade barrier ever. (3) Has globalization improved or worsened income inequality? (4) Has globalization led to secular stagnation? (5) World export volumes and production growing slowly. (6) Not much action in exports of US and Eurozone. (7) China’s trade indicators are weak inside and out. (8) Summers and Rogoff agree on disease, but not cure. (9) Too much debt is one of the main causes of secular stagnation. (10) India’s problem. (11) Focus on market-weight-rated S&P 500 Transportation. (More for subscribers.)

Tuesday, May 5, 2015

Although the dollar might have peaked on March 13 for a while, and the price of crude oil might have bottomed on January 13 for a while, industry analysts who cover the S&P 500 are still lowering their earnings estimates for both 2015 and 2016. They now expect $119.02 and $134.18 per share for this year and next year, down 5.9% and 5.2% from their estimates at the end of last year. For this year, they’ve been lowering their Q2-Q4 estimates as earnings have beaten expectations during Q1 with a 4.7% “hook-up” move so far over the past two weeks, which is typical during earnings seasons.

Monday, May 4, 2015

In recent days, there have been lots of mixed and confusing signals coming out of the Eurozone and US economies, and investors have acted accordingly. On Friday, May Day was a happy day for stock investors as they merrily danced around the maypole. The day before, they all seemed to run for cover. The S&P 500 fell 1.1% on Thursday and rose 1.1% on Friday to 2108.29, just 0.4% below the record high of 2117.60 on April 24. It’s been range-bound since the start of the year.

For bond investors, it was “Mayday! Mayday! Mayday!” every day last week. The 10-year US Treasury yield rose to 2.12% on Friday from 1.93% the week before despite a weaker-than-expected GDP report and a relatively benign FOMC statement on Wednesday.

US yields rose in reaction to the rise in the German government’s 10-year bond yield from this year’s record low of 0.033% on April 17 to 0.37% on Thursday, just before much of continental Europe took Friday off for May Day. Germany’s economic indicators have been showing some strength, and deflationary fears seem to be subsiding. On Thursday, we learned that the Eurozone’s CPI was unchanged during April on a y/y basis as energy prices rebounded. It hit a recent low of -0.6% during January when oil prices were finding a bottom. No one seemed to care that the core CPI rose just 0.6% y/y during April, the same as the month before.

Furthermore, the euro has rebounded from the year’s low of $1.05 on March 13 to $1.12 on Friday, suggesting that Eurozone investors may be losing their interest in US bonds, even though US bonds still yield much more than German bonds. The stronger euro caused the EMU MSCI to sag by 2.8% last week, but rise 0.4% in dollar terms.

Today's Morning Briefing: Mixed Signals. (1) May Day vs. Mayday. (2) Dancing around the maypole. (3) German bond yield backup spills over into US bonds. (4) ECI showing first sign of rising wage pressures. (5) US business surveys were relatively weak in April. (6) CPI vs. PCED. (7) It all depends on FOMC’s interpretation of the data they depend on. (8) Oil exporters selling US Treasuries and other reserves. (9) First day of month often bullish for stocks. (10) Home in the range. (11) Stocks on verge of melt-up? (12) Bonds on verge of meltdown? (13) Signs of life in commodity pits. (14) “Ex Machina” (+). (More for subscribers.)

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ABOUT: Dr. Ed Yardeni is the President and Chief Investment Strategist of Yardeni Research, Inc., a provider of independent investment strategy and economics research. This blog highlights excerpts from our research service, which is designed for investment and business professionals.

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